Governor’s remarks at the “Human Capital and the Labor Market” Conference of the Bank of Israel Research Department
I am happy to open the Research Department’s conference, which deals this year with a very significant economic issue—human capital and the labor market.
In my remarks, I will discuss in short the concept of human capital and its sources in economic literature. Afterward, I will speak about the advantages inherent in increasing and improving human capital, and will briefly describe the situation in Israel and what should be done about it. Finally, I would like to say a few words in honor of the outgoing Director of the Research Department, Prof. Michel Strawczynski.
It appears that the first economist to use the term “human capital” was Irving Fisher in 1906. However, in actuality, in the 18th century already, Adam Smith defined one of the various types of capital in an economy as "The acquired and useful abilities of all the inhabitants or members of the society".
This short description was the basis for defining human capital as it is done today—capital that represents the knowledge, personal skills, abilities, experience, intelligence, and talents of individuals, which make it possible to conduct work that creates economic value and to achieve a high standard of living.
Today, the concept of human capital is broader and richer, and describes not only technical knowledge or years of schooling, but also represents “soft” skills and characteristics such as the ability to solve problems creatively, teamwork, physical and emotional health, and more.
With the years, human capital’s place in the economic literature has grown. Gary Becker and many other good people have thought about, researched, and formally described how an increase in human capital impacts on the economy overall. This is an extensive literature, and I would like to describe, on the tip of the fork, the importance of this concept.
First, human capital is one of the main contributors to economic growth, as the skills of workers have a direct impact on the efficiency of production, and therefore also on the growth of GDP. As there is no direct measure of human capital, one of the ways of measuring it indirectly is through years of formal schooling and various skills tests. Recent research by the OECD indicates that adding 1 year of study can increase overall productivity in the country by approximately 6 percent. This contribution “trickles down” to producing employees as well: additional research shows that the return to wages, meaning the marginal addition to income for each year of study or professional training is about 8–10 percent, on average.
Second, the development of human capital could contribute markedly to reducing inequality. There is considerable empirical basis for the claim that the return on investment in accumulating human capital at an early stage in life is particularly high and impacts on a child’s ability to acquire knowledge and skills at a later age, and to work in more profitable professions.
Yoram Ben-Porat, who was—among other things—the President of the Hebrew University in Jerusalem, formulated one of the important models of labor economics, which models the accumulation of human capital in a formal manner. One of the insights derived from the model, which has since become more sophisticated, was that accumulation of human capital in an early stage has a tremendous impact on the standard of living later on.
One of the research papers I wrote is dedicated to this issue as well, and to some extent is based on the model of Ben-Porat. In it, I show, among other things, that human capital accrued before a person is in their 20s impacts very significantly on life style. The analysis indicates that compared to the heterogeneity in financial wealth and the study abilities of various individuals, the variance in human capital as of the beginning of the 20s has the greatest effect on the person’s standard of living at later ages.
In addition, current literature shows that investment in young ages also has many external impacts that improve the standard of living of the population overall, for example in terms of health.
Reducing inequality as a result of the improvement in human capital in all parts of the population is also reflected in social mobility. We know that the economic situation of the family cell predicts, with quite some plausibility, the economic situation of the children that will grow up in it. One of the ways to “be freed” from this cycle is public investment in improving childrens’ human capital, which in those ages involves acquiring better quality education and schooling and acquiring required skills. Investment in human capital impacts positively on wages, expertise, and standard of living, and thus also on the ability of a person or family who come from a weaker background to improve their socioeconomic standing, and thus increases the equality of opportunity in society.
James Heckman, who a Nobel Prize for his work on the issue of human capital, summed it up as: "Investing in disadvantaged young children is a rare public policy initiative that promotes fairness and social justice and at the same time promotes productivity in the economy and in society at large".
Now I will discuss—in brief, as you will hear a lot about it during the conference—human capital in Israel and what needs to be done to increase it.
The Bank of Israel has indicated several times in the past that Israel lags advanced economies in productivity. This derives mainly from low human capital and insufficient investment in infrastructures. Despite the share of people with schooling in Israel being one of the highest among advanced economies, students’ achievements in the education system are low compared worldwide, and the level of employees’ basic skills is also lower than the OECD average.
The skills gaps begin at an early age, so dealing with the problem requires starting at early ages already in order to prevent the persistence and increase in the gap in later ages. In the Productivity Report, and in other documents submitted by the Bank of Israel to the government, we presented a set of recommendations related to improving the education system, which has the major role in handling and improving the human capital of the young generation.
One of the main recommendations deals education for young ages. Currently, the Free Education Law from age 3 enables a strong majority of children to integrate into the education system, and various activities are carried out to advance the quality of education and the handling in daycare centers. As I noted, as these years are the most important ones for effectively acquiring knowledge and skills, it is critically important to continue advancing these plans.
Despite this, Israel’s expenditure on facilities for babies up to age 2 is low, particularly compared internationally. Despite the many efforts carried out by the functions responsible in this area, low expenditure very much limits the possibility to provide high quality education services to children in these frameworks.
In view of this, we recommended in the past to consider broadening the financing of the education system to younger ages as well. In tandem, the literature shows that the contribution of the education frameworks in early ages is reflected mainly among weaker populations, and thus in term of cost-benefit, it is important to focus government activity in early ages in lower socioeconomic strata, to make it contingent on exhausting labor capacity and to avoid an across the board subsidy.
In order to advance the human capital in Israel, we have emphasized several times in the past that the quality of teaching in Israel needs to be improved. We need to build an effective infrastructure for assessing teachers based on their success in improving grades and skills among the students as well as their success in promoting other educational goals. In addition, we have to ensure that the future generation of the Israeli labor market, which is already among us and is taking its first steps in schools across the country, will receive the basic study tools and skills required for success in the labor market during its studies in these important years. This has tremendous importance, in order for them to be able to lead the Israeli economy to continued growth and success.
As I said, the Bank of Israel has formulated many recommendations for improving the human capital, and today as well we are working forcefully to present updated recommendations to the incoming government.
Before I finish, I would like to say a few words looking to the future. The technological development challenges many areas, and the way we think about human capital is likely to change as well.
Thus, for example, the development of artificial intelligence (AI) has the potential to impact on how we think about human capital in several ways. One of the most significant ways that AI can impact human capital is by automating certain tasks and processes that today are done by humans. This is likely to lead to a change in the types of talents appreciated in the workforce, as well as changes in the types of available jobs.
In parallel, the development of AI could create new work opportunities for people skilled in developing, programming, and managing the AI systems. This could also lead to the development of new industries based on the use of AI. Ultimately, the impact of AI on human capital will depend on how it is adopted and used, as well as the policies and the ventures that will be established to support the switch to a more automated workforce. It is important that communities and organizations will remain updated on AI developments and be proactive in adjusting to potential changes in the labor market.
How do I know that I am not totally wrong here? The last 2 paragraphs that I spoke were written in their entirety by “CHAT-CPT”, the AI tool launched last month.
This cute curiosity illustrates unequivocally that there is the utmost importance to cultivating and constantly improving the human capital while being at the forefront of technology. Incidentally, not only workers and industry will be challenged by the advancing technology; the world of research will as well. For example, one of the issues with which the literature has been dealing in recent years is which employees will be replaced due to the advance of technology. In the past, it was generally accepted that they will be the ones with low labor productivity. In recent years, there has been considerable research occupied with this issue. For example, a leading researcher named Daron Acemoglu shows that under certain circumstances, it will actually be the workers in the middle of the productivity distribution. I dealt with this issue extensively when I addressed the Israel Economic Association about a year and a half ago, and it appears that they have become even more relevant. This is only one example of the challenges facing us—researchers, economists, and policy people.
In conclusion, I would like to switch to a different topic, personal and emotional: The Director of the Research Department, Prof. Michel Strawczynski, is concluding his term this month as Director of the Bank of Israel Research Department, and this is an opportunity to tell you a bit about who he is.
Michel was a wonderful academic resume. He holds a Bachelors degree in Economics and Accounting from University of Uruguay, a Masters and a Doctorate in Economics from the Hebrew University, and he did a post-Doctorate at MIT. Over the years, in parallel with his work at the Bank of Israel, Michel has taught at various academic institutions including Hebrew University, Tel Aviv University, Ben-Gurion University, and Reichman University. In addition, he is a member of the Economic faculty and of Hebrew University’s School of Public Policy, and has been co-editor of Israel Economic Review since its founding.
Michel has published tens of papers, including in leading journals worldwide, which were presented at various universities and central banks around the world. His papers deal with macroeconomic issues, fiscal policy—particularly optimal tax policy, the cyclicality of policy and taxation and fiscal rules, while giving special consideration to analyzing and studying the Israeli economy. Michel has received various prizes for his contribution to the research on the economy in Israel, among others the Gaaton Prize from the Institute for Economic Research in Israel, for his work with Momi Dahan that deals with the connection between the public sector budget and economic growth in Israel.
Michel grew up in the Research Department, and served in various positions over the years: He began at the Bank of Israel in 1993 as an economist and head of the Real Economy and Public Sector area. Afterward he advanced to managerial positions such as Deputy Director of the Research Department and Head of the Macroeconomic Division in the Research Department. Since 2017, Michel has served as Director of the Research Department and over the past 2 years he also served on the Bank of Israel Monetary Committee.
Michel’s contribution to Israel’s economy in the years when he was part of the Research Department in general, and in the past 5 years in particular as Director of Department, is great and significant, and it is difficult to quantify. These were years of the coronavirus pandemic breaking out, in the framework of which we had to conduct monetary accommodation in order to maintain the economy’s stability, Russia’s invasion of Ukraine that led to a global energy crisis and many refugees, dealing with climate crisis risks, political instability and an increase in the inflation rate in Israel and worldwide in recent months. These are all examples that illustrate the complicated reality in which we have had to act in order to maintain the stability of the Israeli economy.
As Director of the Department, Michel led the preparation of one of the most extensive reports submitted to the government. It included recommendations for policy steps for raising the level of productivity in the economy in the long term. From my perspective, Michel’s commitment to the Department and to the Bank during this period and his desire to promote new initiatives in various areas through high-quality research over the years is inspiring and worth of great appreciation.
As part of his roles at the Bank of Israel, Michel led many issues that are related to monetary policy and to economic advice to the government and he enhanced the Bank of Israel’s work connections with research departments at other central banks and various entities in Israel and worldwide, including managing the economic group as part of the Bank of Israel’s entry to the OECD, the joint research group for the earned income tax credit (work grants), and various other teams. In addition, Michel represents the Bank on various committees and serves as co-chair of the implementation committee for enhancing competition. Of course, beyond specific work groups, all the recommendations, and the reference to the reforms of the new governments, and there have been a few of these in recent years, arrive from extensive and high-quality research work of the employees in the Research Department headed by Michel.
In my opinion, what is unique about Michel’s work is his practical involvement in promoting public policy and his ability to translate insights from complex economic models to reality on the ground. The fact that he was the head of the cadet program for the civil service and the head of the Economics and Society Program at the Van Leer Institute in Jerusalem testifies to these qualities in the best way—a combination of economy, academia, mission, society and education.
In the last two years, Michel has led the strategy team that is engaged in reexamining the inflation target in Israel. The highlight of his activity is the initiation, promotion and editing—in which I also took part—of a comprehensive book that includes research articles, most of which were written in the Department, which reviews the various aspects of the inflation environment and monetary policy in recent decades. This book, together with two professional conferences and a lot of work done in the Research Department, form the broad and comprehensive professional basis for the process of examining the inflation target.
Michel, our interactions, in various forums such as the Monetary Committee as well as in private, were always characterized by your being able to incorporate the Department’s professional stances and to get their message across clearly, while at the same time being careful to stay loyal to your professional truth and to clarify your personal stand. Borrowing a term from the world of soccer—you are a combination of a champion player who makes up part of a team and a heart and soul player who is loyal to his professional truth.
Michel, I would like to thank you for your meaningful time at the Bank of Israel. Your extensive economic knowledge and your expertise in the public policy area were reflected in how you led the Research Department, and were an asset to the Bank of Israel. You did a tremendous amount, and I believe that with your return to academia you will find a way to contribute from your wealth of experience that you acquired at the Bank to the Israeli economy and to public policy, and wish you great success in your future path.
I would like thank the organizers of the conference, and wish you all a productive and educational conference, and I am sure it will be very interesting.
Thank you very much.